Under Internal Revenue Code (IRC) Section 168(g), the Alternative Depreciation System (ADS) is generally required to depreciate property that is used predominantly outside of the United States. Additionally, Section 951A of the IRC provides that each U.S. shareholder of a controlled foreign corporation (CFC) is subject to tax on global intangible low-taxed income (GILTI), which is a function of the shareholder’s pro-rata share of the depreciable tangible property of each CFC, referred to as qualified business asset investment (QBAI). When calculating QBAI, a property’s adjusted basis is generally determined using ADS; however, CFCs are permitted to apply the method of depreciation used in keeping their books when computing income or earnings and profits (E&P), as long as the adjustments required to conform to ADS are immaterial.

As Section 951A requires the use of ADS when computing QBAI, CFCs that otherwise are not required to use ADS when computing income or E&P may want to change to ADS to conform their income, E&P, and QBAI computations. Revenue Procedure 2021-26, published May 11, provides procedural guidance for CFCs to obtain automatic consent to make that change.

Overview of Revenue Procedure 2021-26

Prior to the release of Revenue Procedure 2021-26, and pursuant to Revenue Procedures 2015-13 and 2019-43, CFCs on impermissible non-ADS methods of accounting for depreciation could generally request to change their method of accounting to ADS under the automatic change procedures, but CFCs on permissible non-ADS methods of accounting generally could not.

Revenue Procedure 2021-26 now provides procedures, “for a limited period,” for CFCs on both impermissible and permissible non-ADS methods of accounting for depreciation to change to ADS via an automatic method change. “This change is effective for a Form 3115 filed on or after May 11, 2021, for a taxable year of a CFC ending before Jan. 1, 2024,” the revenue procedure states.

Taxpayers making this change should file an automatic Form 3115, “Application for Change in Accounting Method,” using the new designated change number (DCN) 248. A Section 481(a) adjustment is required when making this change.

If a CFC placed property into service in the taxable year immediately preceding the year of change (1-year property), the CFC may change its method of depreciation for that property to ADS if the designated shareholder files Form 3115 and includes a Section 481(a) adjustment, or if each U.S. shareholder files an amended federal income tax return.

Additionally, Revenue Procedure 2021-26 outlines how the designated shareholder of CFC that filed a non-automatic Form 3115 prior to May 11, 2021, requesting permission to change to ADS may convert that request to an automatic request under the new procedures.

With regard to the new accounting method change outlined above, Form 3115 has reduced filing requirements, and certain eligibility rules are temporarily inapplicable. See the full Revenue Procedure 2021-26 for more information.

Other areas discussed

Revenue Procedure 2021-26 also:

1. Updates Revenue Procedure 2015-13 to provide additional terms and conditions applicable to Section 481(a) adjustments made by CFCs. Revenue Procedure 2015-13 requires that a CFC’s Section 481(a) adjustment be allocated to income that had “the same source, separate limitation classification, character, and treatment for purposes of subpart F.” To account for the enactment of Section 951A, the new revenue procedure revises the guidance “to clarify that a CFC’s Section 481(a) adjustment must be taken into account in determining the CFC’s tested income or loss,” unless it is an adjustment specifically excluded from gross income. The new revenue procedure includes an example that “illustrates the application of this approach and the new terms and conditions.”

2. Modifies the audit protection rules for CFCs within Revenue Procedure 2015-13 to clarify that the 150% threshold – i.e., the CFC’s domestic corporate shareholders have foreign taxes deemed paid greater than 150% of the average foreign taxes they paid during the past three years – “is computed with respect to the amount of the [CFC’s] foreign taxes deemed paid, regardless of the extent to which a foreign tax credit is allowed.”

What does CohnReznick think?

Taxpayers should consult their tax advisors to review their facts and determine their best course of action. For many taxpayers, filing Form 3115 to change to ADS with respect to certain depreciable property placed in service by CFCs may be an efficient means of conforming their income, E&P, and QBAI computations, thus relieving administrative burdens that may currently exist. However, situations may exist where filing an amended tax return (i.e., for 1-year property) may be a better option, such as if a taxpayer is already amending a tax return for other items. 

Contact your trusted advisors to discuss your options or for assistance with the preparation of any necessary filings.

Contact

Richard Shevak, JD, Principal, National Tax

862.245.5029

Travis Butler, Director, National Tax

312.508.5821

David Macall, Director, National Tax

973-863-4321

Timothy McMillan, CPA, Manager, National Tax

973.364.7706

_{Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.}